Incorporated in 1934 and acquired by the Union government from Macneill & Barry in May 1960, Garden Reach Shipbuilders & Engineers is a ship builder under the administrative control of Ministry of Defence and caters to the shipbuilding requirement of Indian Navy and Indian Coast Guard. Ships ranging from small to large and advanced vessels including frigates, anti-submarine warfare corvettes, missile corvettes, landing ship tanks, landing craft utilities, survey vessels, fleet replenishment tankers, fast patrol vessels, offshore patrol vessels, inshore patrol vessels, water jet fast attack craft, hover crafts and fast interceptor boats have been delivered to Indian Navy, Indian Coast Guard, the Ministry of Home Affairs and other countries over the last five decades. More than 750 vessels have been built to carry men and materials as well as for surveillance of the coast line. Boats, pontoons, barges, sailing dinghies, fishing trawlers, fire floats, tugs, dredgers, passenger ferries, motor cutters, deck whalers and launchers have been constructed.

Engineering and engine production services are also offered. These include deck machinery items, pre-fabricated portable steel bridges and marine pumps. The shipbuilding division contributed 94.14% to the gross revenues in the financial year ended March 2018 (FY 2018), 90.13% in FY 2017, 91.19% in FY 2016 and 94.76% in FY 2015.

The mini ratna (Category-I) PSU from 2006 is bagging the Defence Minister's trophy for Best Performing Shipyard for four consecutive years since FY 2014. Apart from building India's first indigenous warship, INS Ajay in 1961, other credits include being India's first shipyard to build and deliver the Fleet tanker to Indian Navy, Hovercraft to Indian Coast Guard and landing ship to the Indian Navy. The producer of India's first marine sewage treatment plant also developed the integrated carbon composite superstructure with steel hull for anti-submarine warfare corvette and was the first shipyard to export a warship to Mauritius.

Presently, there are three separate facilities for shipbuilding, all of which are located in close vicinity of each other in Kolkata, West Bengal. The ships are built at the main works unit and at the Rajabagan Dockyard. The third facility is used for fitting out and repair of ships. There is capability to build vessels ranging from five tonnes to 24,600 tonnes.

Currently, there is collaboration with MTU Friedrichshafen GmbH, Germany, to produce MTU 396-04, 4000, 1163, 538, and 183 series diesel engines. A memorandum of understanding (MoU) has been entered into in March 2018 with an overseas entity for supply of components, equipment and services to the Bailey type portable steel bridges, an MoU was signed in April 2018 with Elbeit Systems of Israel to produce unmanned surface vessels in India and an MoU initialled in May 2018 with the ministry of defence of another jurisdiction for a shipbuilding project.

The Offer and the Objects

The offer comprises sale of 292.10 lakh shares by the government of India. At the lower price band of Rs114 per share, the issue size works out to Rs332.99 crore. At the higher price band of Rs 118, the issue size is Rs 344.68 crore.

The minimum bid lot is 120 equity shares and in multiples of 120 equity shares.

The objects of the issue is to carry out the divestment program of the Central government apart from the benefits of listing the equity shares on the BSE and the NSE and to enhance visibility and brand image and provide liquidity to the existing shareholders.

The Union government will hold 74.5% of the total paid-up equity share capital post listing.

Strengths

There is a long-standing relationship of more than five decades with Indian Navy and Indian Coast Guard. Over 97 ships have been delivered to Indian Navy and Indian Coast Guard.

The product portfolio is wide. There is an established track record.

The plant is modern and capable of offering end-to-end solutions.

There are established capabilities for in-house design.

The order book for all the product categories was Rs 20313.61 crore end July, implying over 15x last three years' average sales. The shipbuilding order book from Indian Navy and Coastal Guard consisted of orders for 13 vessels, with an aggregate outstanding value of Rs 20029.42 crore. In addition, there is lowest bidder status for four large survey vessels and eight anti-submarine warfare shallow water craft from the ministry of defence and one ocean-going passenger and cargo ferry vessel that is presently not part of their order book as the letter of award has not been issued

Being qualified for the Make-in-India initiative under the defence procurement procedure grants indigenous manufacturers a competitive advantage when supplying to the domestic market. The ministry of defence accords the highest priority to indigenously designed, developed and manufactured products for capital procurement. Repeat customers Indian Navy and Indian Coast Guard constitute part of the domestic market and are, therefore, required to give preference over global shipyards in certain circumstances.

The significant expansion in fleet ship size planned by Indian Navy and Indian Coast Guard includes local construction of component. Over the next decade, Indian Navy and Indian Coast Guard will acquire indigenous aircraft carrier, fleet support ships, frigates, mine counter measure vessels, fast attack crafts, patrol vessels, new-generation corvettes, survey vessels and fuel barges. As per rating agency Icra, Indian Coast Guard plans to take the fleet strength to 200 ships from 130 currently and to 100 aircraft from 62 currently by 2022. As of now, 70 ships are under construction in six shipyards. The bidding process for 30 more ships is in process. The Central government has approved around Rs 32000 crore for the expansion. Indian Navy's estimated capital budget for up to 2027 amounts to Rs 450000 crore. The Coast Guard is intending to augment its existing fleet by 20 - 25 vessels over the next 10 - 15 years

The focus will be on repair and refitting of Indian Navy and Indian Coast Guard vessels. There will be substantial market opportunities in the coming decade and beyond in maintenance, repairs, refits and upgrades of Indian Navy and Indian Coast Guard warships.

An MoU was signed in October 2017 with an engine manufacturer for development of engines for marine applications. The scope of collaboration is to produce diesel engines in the range 50-500 kW for diesel alternators for marine applications for Indian Navy and Indian Coast Guard vessels with an aim towards self-reliance and to promote Make-in-India initiatives. All the engines will be sold to the ministry of defence.

Global markets will also be explored. They intention is to market all vessel sizes for export to various geographic locations. Hopes are high of exporting small- and medium-sized warship and patrol vessels to South East Asia, west Asia, African countries and Latin America

Weaknesses

There is significant dependence on Indian Navy and Coast Guard. Award and execution of contracts depend on budgets allocation to the ministry of defence. A decline or reprioritisation of funding in the Indian defence budget, any reduction or unavailability of funds to Indian Navy and Indian Coast Guard or delay in the budget process can have an adverse impact on the funding of existing contracts and award of new contracts.

Shifts in domestic spending and tax policy, changes in security levels, defence, and intelligence priorities and general economic conditions can affect fund flows.

Indian Navy and Indian Coast Guard require constant innovation and improvement in efficiency. Thus, shipbuilders have to constantly upgrade processes and products to incorporate the latest technology to keep up with the demands of modern shipbuilding.

The competitive marketplace for shipbuilding is steadily moving from a nomination process to competitive bidding. Strategies have to be developed to compete in the bidding process for projects and procurement of components.

The government of India's policies have a significant role. Increase in salary and allowances for government and public sector employees will increase the expenses and can adversely affect the financial condition.

Opening of foreign direct investment in the defence sector to encourage competition will hit the status as a nominated production agency. A transition will have to be made to competitive bidder. The process can disrupt revenues and affect the margins.

Dependency on MoD for order and its requirement of secrecy will hamper in complying with the disclosures specified in the Companies Act, listing requirement of stock exchanges and other corporate governance regulations. Therefore, disclosure of information post listing can be expected to be limited.

Most of the orders in hand are at fixed prices. There is sufficient cushion to absorb any increase in raw materials prices. The situation will be different in competitive bidding.

The financial track record available in the prospect lacks luster and is highly volatile.

The business is cyclical. Shipbuilding projects have a typical order-to-delivery period of 23 to 66 months. Recognition of revenues and expenses occurs in large parts in the middle period of the project, when expensive equipment and sophisticated systems are installed in the vessels. The beginning period of a project and the end period of a project give rise to significantly lower revenues and expense recognition compared with the middle period. As a result, revenue and expense recognition is heavily weighted toward five-year cycles of one to two years of lower revenue and expense recognition, followed by one to two years of significantly higher revenue and expense recognition, followed again by one to two years of lower expense recognition.

Operating cash flows were negative in FY 2017 and in FY 2018 due to technology modernization program and lower operations.

The entire business is based out of a shipyard in Kolkotta. Any interruption due to modernization, as was the case in FY 2017, repairs, major accidents, unexpected natural calamities and unfavourable weather can have a significant impact on the financials.

Valuation

9288000 equity shares were bought back from government at Rs 83.58 per share in January 2018.

Net sales were up 46% to Rs 1344.62 crore and the operating profit margins stood at -1.5% in FY 2018 compared with -17.6% in FY 2017, resulting in loss at the operating profit level of Rs 20.63 crore compared with loss of Rs 162.67 crore in FY 2017. Other income declined 17% to Rs 179.23 crore. Interest cost was down 75% to Rs 1.90 crore, while depreciation increased 9% to Rs 28.96 crore. Thus, profit before spurted 535% to Rs 127.75 crore. After total tax jumping 373% to Rs 40.95 crore, profit after tax jumped 657% to Rs 86.80 crore. There was a setback in FY 2017 due to technology modernization at the facilities. Teh financials came back on track in H2 of FY 2018. As such, comparison between FY 2018 and FY 2017 does not reveal the correct picture.

At the higher price band of Rs 118, the P/E on FY 2018 EPS (on current diluted equity of Rs 114.55 crore) of Rs 7.6 works out to 15.6.

At lower price band of Rs 114, the P/E on FY 2018 EPS (on current diluted equity of Rs 114.55 crore) of Rs 7.6 works out to 14.9.

There is no comparable listed shipyard supplying mainly to the ministry of defence. The nearest comparable player is Cochin Shipyard (CS), a public sector company under the ministry of shipping that builds and repairs ships for the commercial as well as defence sector. CS is currently trading at around P/E of 13.5 times FY 2018 EPS. The enterprise value/unexecuted order book works out to just 0.016 compared with 0.83 of CS.

The strong order book will ensure revenue visibility in the coming years. However, due to the cyclical nature of the business due to delivery period ranging anywhere between 23 to 66 months makes margins difficult to predict given the fixed-price contracts.

*EPS is on post issue equity capital of Rs 114.55 crore of face value of Rs 10 each & FY 2013 and FY 2014 financials are as per old Indian AS, while FY 2015, FY2016, FY2017 and FY2018 financials are as per new Ind AS# EPS not annualised due to seasonality of businessFigures in croreSource: Capitaline Database